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The effect of financial development on the investment cash flow relationship: cross-country evidence from Europe

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  • Becker, Bo
  • Sivadasan, Jagadeesh

Abstract

We investigate financing constraints in a large cross-country data set covering most of the European economy. Firm level investment sensitivity to cash flow is used to identify financing constraints. We find that the sensitivities are significantly positive on average, controlling for country and industry fixed effects, as well as firm level controls. Most importantly, the cash flow sensitivity of investment is lower in countries with better-developed financial markets. This suggests that financial development may mitigate financial constraints. This effect is weaker in conglomerate subsidiaries, which are likely to have access to internal capital markets and depend less on the outside financial environment, and possibly for firms in industries with highly liquid assets as well. This result sheds light on the link between financial and economic development. JEL Classification: , E44, G31, L10

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0689.

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Date of creation: Oct 2006
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Handle: RePEc:ecb:ecbwps:20060689

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Keywords: Europe; financial constraints; Financial Development; Investment;

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Citations

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Cited by:
  1. Giorgio Calcagnini & Annalisa Ferrando & Germana Giombini, 2013. "Multiple Market Imperfections, Firm Profitability and Investment," Working Papers 1305, University of Urbino Carlo Bo, Department of Economics, Society & Politics - Scientific Committee - L. Stefanini & G. Travaglini, revised 2013.
  2. Sai Ding & Alessandra Guariglia & John Knight, . "Investment and financing constraints in China: does working capital management make a difference?," Discussion Papers 11/06, University of Nottingham, GEP.
  3. Ding, Sai & Guariglia, Alessandra & Knight, John, 2010. "Does China overinvest? Evidence from a panel of Chinese firms," SIRE Discussion Papers 2010-110, Scottish Institute for Research in Economics (SIRE).
  4. Ferrando, Annalisa & Marchica, Maria-Teresa & Mura, Roberto, 2014. "Financial flexibility across the euro area and the UK," Working Paper Series 1630, European Central Bank.
  5. Minjia Chen & Alessandra Guariglia, . "Financial constraints and firm productivity in China: do liquidity and export behavior make a difference?," Discussion Papers 11/09, University of Nottingham, GEP.

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